EUR/USD: Divergence In Sentiment Just Continues To Widen

The complete divergence in both economic sentiment and monetary policy between the European Central Bank (ECB) and US Federal Reserve is turning into a continually widening tunnel, which has just widened even further. The overall Eurozone inflation reading for December was just announced at an annualised negative 0.6%, meaning more Eurozone deflation than forecast and following the trend set by Germany yesterday. Once again, the main catalyst behind the deflation reading has been the complete drop in the price of oil but with the commodity still unable to find a floor, further deflation is expected as the year continues.

The downside deflation threats that the Eurozone faces this year are severe and will continue to reaffirm the longer-term bearish outlook on the Eurodollar. Although all attention is on the crumbling oil prices being the main culprit behind the deflation reading, core inflation was still announced at a record low of 0.5% - highlighting the challenge the ECB face when it comes to reinvigorating economic growth. Meanwhile, the USD is continually being supported by repeated indications from the Federal Reserve that it will be raising US interest rates and when the time for a rate increase approaches, the probable USD rally will inevitably weigh on the Euro. With these factors in mind, it is increasingly difficult to envisage the EUR/USD bouncing to the upside to anything other than USD profit-taking as investors lose patience with the fact that the Federal Reserve will not rush to raise rates.

Meanwhile, the Ruble has continued to face punishment following an extended round of economic sanctions on Russia now being followed by an unexpected interest rate cut by the Central Bank of Russia (CBR). The USD/RUB has now approached 71.7625 with the pair very much appearing to be on track to close above 70 for the first time in history. As continually mentioned, the CBR faces an extremely tough task in preventing Ruble weakness. Interest rate adjustments are leading to further Ruble weakness, because it just provides clarity to traders that it is struggling to tame Ruble weakness.

The issue that the CBR faces is that the economic outlook is so aggressively against the Russian economy that it just highlights to traders that the longer-term Ruble picture is very much more weakness. Extended rounds of economic sanctions are just going to add more pain to an economy that is already about to enter an inevitable recession later this year. Not only this, but the economy is certain to face extra unexpected pressure following the collapse in the price of oil. Current expectations are for the pair to re-climb to the historic high of 80 before April, but if the CBR continues to shift its stance on interest rates, it could happen sooner than that.


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